Coinsurance/Insurance to Value Revisited: An Essential Concept in Property Insurance
It must be emphasized that a loss will not be paid on a replacement cost basis (without deduction for depreciation) unless the damages are actually repaired or replaced. Until repair or replacement is completed (or, in actual practice, usually once work is started), the loss is adjusted on an actual cash value basis; that is, with a deduction for depreciation. The insured has six months in which to make claim on a replacement cost basis. In most policies, the
insured only needs to give notice of the intent to make claim on a replacement cost basis. They do not need to make the actual repairs/replacement within that period. However, there is an exception to this provision. If the cost to repair or replace does not exceed $2,500 or 5 percent of the limit on the damaged building, whichever is less, the loss may be settled on a replacement cost basis from the outset.
By obtaining proper coinsurance and insurance to value, insureds can reduce the risk of underinsurance. Agents and brokers provide a valuable service to their clients by explaining these concepts and encouraging the purchase of appropriate amounts of insurance. It facilitates the adjustment process when the insurance to value requirement is met.
Avoiding or Minimizing the Problem of Underinsurance
What can agents and insureds do to avoid or minimize the problem of underinsurance? Determining accurate replacement value can be troublesome because there are a variety of tools or methods that can be used and they can have different results. For that reason, it can be said that determining replacement value is not an exact science. It is estimated that 60 percent of homes are underinsured by as much as 20 percent, so it is understandable why there is frustration concerning obtaining an accurate figure for replacement value. If the insured is underinsured, he or she will pay a penalty in the event of loss.
Back in the late 1980s and 1990s when insurers offered “guaranteed replacement cost” insurance, insureds with that protection did not have the problem of underinsurance that can exist today. However, today many companies do not offer that coverage and many insureds are reluctant to pay the price for it